Understanding the Euro: Key Questions for the ECB Ahead of Meeting

Key Questions for the ECB

By Yoruk Bahceli and Stefano Rebaudo

LONDON, Jan 30 (Reuters) - The European Central Bank meets next Thursday with policymakers relieved that the threat of fresh U.S. tariffs over President Donald Trump's demands to buy Greenland proved short-lived. 

The immediate risk has passed but the uncertainty Trump has unleashed lingers, weighing on the dollar and prompting policymakers to worry about the euro's spike higher.

What Will the ECB Do?

Here are five key questions for markets:

1/ What will the ECB do?

Keep rates steady at 2% for the fifth straight meeting. 

With Trump backing down from imposing extra tariffs on some of Europe's biggest economies, economists reckon ECB chief Christine Lagarde will stick to her mantra of a data-dependent, meeting-by-meeting approach to monetary policy, without committing to any given rate path.

"These three points are not a mere formality — they matter because the world is subject to uncertainty and geopolitical shocks," said UBS chief European economist Reinhard Cluse. 

Impact of U.S. Trade Tensions

2/ What does the threat of fresh U.S. trade tensions mean? 

For now, a stronger currency. 

The euro briefly topped $1.20 this week, reaching its highest level since 2021. It is up 3% over the last two weeks. 

"The Greenland thing has done one thing: The euro is much higher," said Christian Schulz, chief economist at Allianz Global Investors.

He expects the ECB on Thursday to assess some of the risks facing the economic forecasts it will update in March. 

Policymakers are flagging concern over euro strength and its potential to push inflation, expected below the 2% target this year and next, even lower if it continues appreciating. 

Had Trump proceeded with imposing tariffs on Europe, that would have hit growth and raised inflation slightly. 

Longer term, what matters more is the degree of uncertainty Trump’s trade policy reversals pose for the economic outlook, Lagarde has said, which could hurt growth.

Will the ECB Act Against a Rising Euro?

3/ Will the ECB act against a rising euro? 

Not yet, economists reckon. 

Traders are betting a firmer euro has raised the odds of an ECB rate cut this year and see a roughly 20% chance of another cut by the summer given recent policymaker comments. 

However, economists say that crossing $1.20 isn’t a big deal for the ECB, which cares more about the speed and scale of moves rather than outright levels. 

And the trade-weighted euro which it monitors has risen a lot less as the move has been driven by the fall in the dollar rather than a broad euro rise.

Ross Hutchison, head of euro zone market strategy at Zurich Insurance Group, said it would take speedier moves breaking out beyond $1.25 to prompt a significant downgrade to ECB inflation forecasts. 

On the flipside, investors will also watch what the ECB says about a surge in European natural gas prices, which may ease downward price pressures. 

Resilience of the Euro Zone Economy

4/ How resilient is the euro zone economy?

More resilient than it has been for some time.

It grew 1.4% last year, the fastest clip since 2022, economists polled by Reuters estimate, despite all the trade tensions, demonstrating domestic resilience. They expect 1.2% growth next year.  

Key to the outlook is how quickly Germany starts unleashing its fiscal bazooka. 

"That delivery of the fiscal stimulus can help to lean against some of the impact of high uncertainty that is still weighing on the euro zone growth outlook," said BNP Paribas’ head of developed market economics Paul Hollingsworth.

German spending picked up slower than expected last year, so some economists are skeptical of how quickly the country can ramp it up this year, which could mean growth ends up a bit slower than expected.

Implications of Fed Independence Concerns

5/ What do the Fed independence concerns mean for the ECB?

A less independent Fed that sets looser policy than usually expected would send the dollar even lower and raise U.S. inflation, economists said. 

That risk is in focus after the Trump administration threatened Fed chair Jerome Powell with a criminal indictment. 

The stronger euro that would result would weigh on euro zone inflation, and higher U.S. Treasury yields could spill over into euro zone borrowing costs, not to mention financial stability risks.

For now the ECB won't debate any rate change but such risks could upset that outlook, says chief economist Philip Lane. 

The ECB issued a rare joint statement with other major central banks earlier in January expressing solidarity with Powell and stating that central bank independence was crucial for price and financial stability.     

(Reporting by Yoruk Bahceli and Stefano Rebaudo; editing by Dhara Ranasinghe and Hugh Lawson)